Expert answers to the global meltdown

Freefall: America, free markets and the sinking of the world economy
Author: Joseph E. Stiglitz
Publisher: Allen Lane
WHAT would the late Ayn Rand, author of Atlas Shrugged, have said about the recent financial crisis and the US government’s massive bailouts of banks and financial institutions?

Rand, a strong advocate of laissez-faire capitalism, believed that the government’s role in an economy was to protect individual rights without intervening in the conduct of free market.

To the dismay of Rand and her cult believers, the US government, in its efforts to subdue the crisis, has done everything that violates her definition of capitalism.

The government has done little to protect individual homeowners from foreclosures but has done a lot for banks. It has sustained them by giving them massive amounts of taxpayers’ money, despite reckless wrong doings.

Worse yet, some of these crooks and undeserving bankers have shamelessly paid themselves fat bonuses with the handouts and continue to serve as executives.

While Rand is no longer present to condemn the mess, Joseph Stiglitz is. In his new book, Freefall: America, free markets and the sinking of the world economy, Stiglitz outlines the crisis, identifies the causes, delineates the impact, fires salvos at bankers, criticises regulators and policy makers, and puts forth solutions for a better future.

Most importantly, he debunks economic theories and provides a historic background of the financial market.

This gives the reader a thorough understanding of the crisis and the economic forces at play.

Stiglitz’s account brings us back to the 1980s when deregulation and privatisation were Ronald Reagan’s top priority. This period also saw the replacement of Paul Volcker by Alan Greenspan as chairman of the Federal Reserve Board.

The formation of this duo, along with Treasury Secretary Robert Rubin, set the stage for rapid deregulation and low interest rates, encouraging banks to engage in risky activities and allowing consumers to spend beyond their means. Hence, the recent crisis did not just happen as bankers claim. “It was created,” says Stiglitz.

Much has been said about the crisis. Written in different formats, from diverse angles, by many people and for different objectives, the crisis has been put under a magnifying glass, analysed and, hopefully, its lessons learned.

But nobody does a more comprehensive job than Stiglitz. Although the material is difficult at times, Stiglitz manages to put things into perspective in a succinct and intuitive manner.

For instance, credit default swap, a type of credit derivative that can put banks and financial institutions in trouble, is cleverly defined in AIG’s context, as the “insurance” that AIG and investment bankers sell to insure investors against the collapse of banks.

But Stiglitz’s full ammunition is aimed mostly at bankers, calling their wheeling and dealings the greatest scam of the century.

Encouraged by lax regulation and tempted by the kind of quick profits that investment banks were making, commercial banks abandoned the conventional role of lending.

They began to make extremely risky loans and engage in securitisation, a process wherein subprime mortgages are bundled up, repackaged and converted into securities to be sold to investors.

As these banks became bigger and bigger, they became confident that the government would rescue them because they were simply to big to fail. And they were right.

Not only did the regulators not pop the asset bubble, they grew it. Alan Greenspan had fuelled the heat of risky trading by continuing to lower interest rates, Ben Bernanke allowed the issuance of subprime mortgages, and Henry Paulson, as a CEO before becoming the Treasury Secretary, led Goldman Sachs to new heights of leverage.

Stiglitz describes them as schizophrenic for refusing to acknowledge the danger looming ahead, let alone taking action to prevent it.

A Nobel laureate professor with stellar practical experience serving the World Bank and former US President Bill Clinton, Stiglitz’s passion in global economics and his decade-long warning on an impending crisis have made him the person the United Nations turned to as chairman of a panel of experts on the global meltdown’s causes.

The answers are in this book; all except Stiglitz’s confidence in President Barack Obama. Stigllitz is evidently doubtful of Obama’s ability to overcome the challenge as he has not taken firm action to restructure the banking behemoth as promised.

Moving forward, Stiglitz thinks economies need a balance between the role of markets and governments. Though that may seem very true in the wake of what we have just experienced, Stiglitz alone will not be able to convince the formidable-looking Rand, I reckon.

Note: Readers interested in Ayn Rand’s view on capitalism can check out her book titled Capitalism: The Unknown Ideal.